Saturday, January 28, 2012

Remember
way, way back in November and December 2010 when Ireland was at the head of the
line in the Eurozone debt crisis? Since all of the kerfuffle back then,
the Irish have pretty much been given a pass on their debt by the mainstream
media who, instead, have been focusing on Greece, Spain and now Portugal. I
thought that given the activity regarding their PIIGS partners in recent days
and weeks, that it was about time for an update on Ireland's fiscal situation.

Ireland
released its most recent Financial Statement in December 2011 (i.e. Budget
2012), oddly enough, on the 90th anniversary of the signing of the Treaty that
restored Ireland's sovereignty. I'll pick out a few of the salient points
for you.

Let's
take a quick look at some data first, starting with unemployment:

Since
the beginning of the Great Contraction, Ireland's unemployment has risen from
just 4.8 percent in January 2008 (remember the Celtic Tiger?) to a high of 14.6
percent in April 2011. The most recent data release shows that the rate
has not fallen by much and currently sits at a rather hefty 14.3 percent, above 14 percent were it has stubbornly remained for nearly a year.

Notice
that Ireland's debt was very high in the early part of the 1990s, in part,
because their economy was simply not growing. As the Celtic Tiger
phenomenon developed, output (i.e. economic growth) outgrew the level of debt
growth, resulting in the country’s debt-to-GDP level falling to a low of 24.8
percent in 2007. Unfortunately, that scenario was not to last. Ireland’s debt-to-GDP rose very, very
quickly over the following three years to its current level of 96.2 percent.

In
large part, Ireland's current problems stem from the implosion of the country's
real estate market which, prior to the Recession, was among the fastest growing
in the world. Here is a graph showing what happened to real
estate prices in Ireland over the past 20 years:

Here
we thought that America's housing market readjustment was bad! Ireland
experienced the largest property price increase among Europe and North American
countries with values quadrupling over the period between 1997 and the peak in
2007. Nationally, average house prices have fallen to the same level that
they were at in the second quarter of 2002. Some statistics show that
house prices in Ireland have fallen by an average of 58 percent from their
peaks, one of the worst drops in residential real estate value in the world. The
drop in the value of real estate caused massive stress in the country's banking
system which, as was the case in the United States, had been only too willing
to lend out mortgage money. This necessitated bank recapitalizations that totaled
32 percent of GDP, actions that the government could ill-afford as the economy
ground to a halt. In the end, funding for Ireland's banks ended up
costing the ECB and Ireland's Central Bank about €150 billion.

That's
enough background. Now let's look at the present, keeping in mind that,
according to the Eurostat website, since its inception, the European Commission
has had in place a procedure called the Excessive Deficit Procedure (EDP) that would allow the EC to
sanction nations whose budget deficit exceeded 3 percent of GDP and whose
public debt exceeded 60 percent of GDP.

Back
in December, Ireland's Finance Minister, Mr. Michael Noonan, predicted that
Ireland's nominal GDP would grow by 2.5 percent in 2012 and states that
"...all forecasters agree that growth will be significantly stronger in
2013 and subsequent years...". Not according to the IMF! He
attributes this growth rate to Ireland's very, very low corporate tax rate of
12.5 percent and is committed to keeping it low to keep the economy strong,
even though he has been under international pressure to raise it. Here is a chart showing just how low
Ireland's corporate tax rate is compared to its Eurozone partners:

Ireland's
corporate tax rate is the third lowest among its fellow Member States, just
below Bulgaria and Cypress (both at 10 percent) and well below the EU-27
average of 23.2 percent. Keep that and Ireland's very high unemployment
rate in mind the next time your local politician insists that your country must
lower corporate income taxes so "the jobs will come". While
there are other factors that have negatively affected Ireland's economy,
ultra-low corporate taxes do not seem to be a long-term job creation strategy. It
is also important to note that, as Ireland's economy imploded between 2007 and
2010, tax revenues fell by one-third, a point that should not go
unnoticed by politicians around the world.

As I
noted above, Ireland's real estate sector has been decimated. The
development and construction sector comprised 20 percent of GDP in the peak
years and had been reduced to around 5 percent in 2011. This implosion
led to the loss of 164,000 construction sector jobs. The decline in the
value of residential real estate has also led to families saving rather than
spending, further impacting the economy negatively. To prod the real
estate market back to life, in its most recent budget, the Irish government
reduced the Stamp Duty on commercial property transfers from 6 percent to 2
percent but, oddly, nothing was done to change the 1 percent Stamp Duty on
property transfers up to one million euros.

The
Irish government has also taken steps to address the problems facing those who
purchased their properties during the height of the property boom (i.e. those
who both borrowed and paid too much). For purchasers who bought their
homes between 2004 and 2008, the rate of mortgage interest relief has been
increased to 30 percent. For those who wish to buy a home in 2012, first
time buyers will get mortgage interest relief of 25 percent and non-first time
buyers will get mortgage interest rate relief of 15 percent, both up from the
proposals of the previous Government. This program ends in 2018.

Ireland's Finance Minister estimates that the deficit for fiscal 2011
will be 10.1 percent of GDP (less than the 10.6 percent required by the EU/IMF
bailout agreement), down from 11.5 percentof GDP in 2010, dropping to a
target of 8.6 percent in 2012. To reach the 2012 target, the government
needs to cut an additional €3.8 billion in both expenditures and revenues.
To meet this goal, the government held fast on not raising both personal and corporate income taxes. Back in late 2010, the previous
Government agreed with the IMF and the EU that VAT would be increased by 2
percentage points by 2014. Rather than delaying the increase, the current
Government will raise the VAT by the full 2 percent in 2012, raising the rate
to 23 percent so that they can increase revenues much sooner.

You
will notice that in this summary, the budget deficit in 2012 is still projected
to be 10 percent of GDP, just over three times the EU limit as noted above. Ireland
needs the additional €3.8 billion in fiscal management as I noted above,
to achieve the 8.6 percent of GDP.

Here is a graph showing how the debt
interest burden in Ireland has risen in recent years with the debt interest-to-GDP
ratio reaching 5 percent and consuming 14 percent of all tax revenue, up from
3.5 percent in 2007, a situation that will only become worse if the world’s
bond traders lose faith in Ireland’s ability to service its debt:

How
much sovereign debt does Ireland have? In 2010, Ireland's debt reached €144.4 billion or 92.6 percent of GDP. Debt-to-GDP levels rose
between 2007 and 2010 for several reasons including large budget deficits, loss
of tax revenues as the economy ground to a halt, the high cost of bailing out
the country's banking system and the significant fall in GDP from 2007 on. In
2007, general government debt was a mere €47.4 billion (25 percent of
GDP). Here is a table showing the forecasted debt and debt-to-GDP figures
for the period from 2011 to 2015:

Ireland’s
rather stubborn debt-to-GDP ratio is projected to remain well above 100 percent
of GDP over the next five years, hitting a peak of 118.3 percent in 2013, well
outside of current European Community guidelines as I noted above. As well, despite reductions in deficit spending, Ireland's overall debt will rise from €163.8 billion to €203.8 billion, an increase of 24.4 percent in just five years.

Ireland
is projecting real economic growth ranging from 1.6 percent in 2012 to 3.0
percent in both 2014 and 2015.
While no one can predict what will happened four years out, it most
certainly would appear that the Eurozone is heading into a recession in 2012,
making the 1.6 percent growth rate a less than likely projection, particularly
given that GDP growth in the third quarter of 2011 was negative 1.9 percent compared to the quarter before. To
increase their imports, they are also counting on G20 economic growth for the
next two years of 3.8 and 4.6 percent, another highly optimistic scenario.

When
summarizing all of the projections, Ireland’s government projects that the
country’s deficit will fall to a low of 2.9 percent of GDP by 2015 as shown on
this table, just a smidgen under the EU limit of 3 percent:

In summary, we need to remember that Ireland has already had a massive bailout totalling €85 billion and is still showing economic numbers that are not particularly great. Like
governments around the world, Ireland is relying heavily on growing its way out
of trouble, a highly risky proposition. They are hoping that increased
tax revenues resulting from an expanding economy will help reduce the gap
between revenues and expenditures and that the increase in GDP will have the
added benefit of decreasing the country's debt-to-GDP ratio. With the IMF now projecting that Europe could return to
recession in 2012, all of Ireland's hard fought battle with crippling debt
could well be in vain and it is my guess that Ireland will require further assistance from the EFSF, IMF and EU. Leaders of the Free World who are spending more than you are receiving in revenue, take note! This could well be your future.

10 comments:

APJ:I can only imagine how long it took you to write this versus how long it took me to read it!This is very interesting information.Do you think that health care in the U.S. is in a bubble?What about college education?If so, what will happen to our economy as those bubbles correct themselves?

I read an interesting article in financialsense recently entitled the GDP Deception. The author states that GDP is simply money supply times money velocity.Ten years ago, the money velocity was 2.0. Today it is 1.6. If the money supply had stayed the same, GDP would have decreased. But, thanks to increasing government debt, which increases the money supply, GDP has increased.Is GDP really that simple?If so, I am blown away!Don Levit

You are right about the money supply x velocity (MV) is the nominal GDP (PY). Where Y is the real GDP and P is the price level. PY is an expression of norminal GDP. More money in the economy is going to result in price increase, thus higher nominal GDP, but it will not increase the real GDP or output level, if you like.

Yes Don, it was a LONG write! I cut out quite a bit after I had written it.

Health care in a bubble? I really can't say.

College education in a bubble? Definitely. From what I have read in the past, during the Great Recession, college tuitions did not correct downwards, making them even more expensive in relative terms.

I'll have to find the article on FS and read it before I can comment. Those guys are pretty smart cookies and they are one of the few that predicted the implosion in the housing market well before it happened.

In the US, the causes of the housing bubble have reported to have been a combination of low interest rates set by the FED and government policy of ignoring credit worthiess. What caused the bubble in Ireland?

Also, what is the percent of government outlay to social programs? The IRS publishes this data for the US taxpayer, but is it available in Ireland for their taxpayers?

We definitely need to reassess our priorities here in Ireland but don't get carried away by a few statistics either. The massive increase in unemployment could only come from a country where the property market has collapsed and it is employing 25% of the workforce. Drawing false parallels between the unemployment rate and our corporate tax rate is infantile - you might as well link it to our score in the Eurovision.Economic policy requires far more subtlety than just grabbing a few statistics and using it to bolster an opinion that is already held.

The point I was trying to make regarding the connection between corporate tax rates and unemployment is that there is NO connection. That is exactly what we are not being told on the other side of the Atlantic. Just because corporate taxes are low does not mean that the jobs will come, it just means that corporations have the potential to save taxes.

I would very much disagree about their being now connection between the low corporate tax rates and the huge number of multi-national jobs in IrelandAnd yes, there is a huge number if one considers that these are modern 21st century companies. They are never going to employ that many people and do not need large admin staff for example.Yes it would be really nice to attract a couple of large "old school" companies that employ thousands of people, but on the plus side, these companies are probably running at their peak of efficiency and so unlikely to be able to cut staff.

The causes of the Irish bubble were the same; low interest rates set by the ECB, i.e., the Bundesbank, much too easy credit and insane policies adopted by the previous government that served only to enhance the bubble.

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.